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She turned 55 in 2012 but the loan was taken out in 2011.

Again - it's not the date of the loan. The critical factor is that she RETIRED in 2011, while she turned 55 in 2012.

Guess she owes penalties if she goes down this path.

Yes, since she turned 55 in 2012, if she had retired in 2012, she would still owe taxes on any withdrawals (loan and/or account balance) but would not owe any penalties. Since she retired in 2011 and turned 55 in 2012, she is now subject to penalties for all withdrawals (loan and/or account balance) until she is 59 1/2.

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